PLEASE NOTE: This article has an update (April 2011) at the end regarding the government's case against Tobias H. Elsass, who provides "services" to fraud victims related to this particular provision of the tax code. Interestingly, a Google search reveals that someone(s) has gone to a lot of trouble to make anyone interested believe that the Tobias H. Elsass operating the Fraud Recovery Group is the not same Tobias H. Elsass whose license to practice law is suspended. They are one and the same.
While I go to great lengths in this article to make it clear that there are some very questionable activities going on with respect to this tax code provision, and caution readers accordingly, this update and the related attachments make it possible for you to read the government's pleadings and get their wonderfully cogent explanation as to how this code section is intended to be applied, as compared to the fraudulent activities that they allege.
Internal Revenue
Code §165, as codified in Title 26 USC §165, is
a door through which those who have suffered certain uncompensated
casualty losses may recover as much as 35% of their losses,
and you, as that person's investigator are the key to the
door. Even assuming that the investor has a competent attorney
and a knowledgeable CPA, they are highly unlikely to get through
that door without you.
Although this has been referred to as one of
the "best kept IRC secrets," it
would be equally apt to refer to it as one of the "IRC's
highest hurdles." Although the IRS' position
in some of these cases may initially appear to be unreasonable,
once you understand the nature of this IRC provision, I believe
that you will agree that those who would apply for this tax
relief should have a high burden to meet.
Before delving into the nuts and bolts of this
thing, a simple introduction to basic tax issues, and terminology,
may be in order. I beg the forbearance of any tax professionals
among us as I try to make this as simple as possible.
First, consider the word "loss." There
is nothing particularly unique about the way that this term
is used in the tax code; I suppose that a loss could be generally
characterized as any event that has a negative impact on net
worth. Rather than become bogged down in semantics, let's
just accept that if your stock portfolio takes a dive, your
car burns up, your ship sinks, your home is burglarized, or
you become the victim of fraud, you suffer some sort of loss.
The tax code treats these losses in different
ways, according to the attendant facts and circumstances,
and certain losses are treated far more advantageously than
others. For example (looking strictly at the issue of loss)
if your Client entrusted a broker with a million dollars with
which to buy a certain stock, it wouldn't make much difference
whether the broker stole their funds outright, or the stock
value plummeted to zero, but the tax code would treat those
events dramatically differently.
Next, consider the word, "casualty."
While the term is used a bit differently in the tax code than
most of us use it in daily life, there is a connection to
common usage. Car wrecks, train wrecks, and bombs cause casualties
- not old age. The dead are just as dead either way, but casualties
are the consequence of sudden, and unusual events generally
(but not exclusively) described in the tax code as fire, storm,
shipwreck, and theft.
Consequently, the million dollars your Client
lost when their broker stole their investment capital is a
"casualty loss," whereas the loss due to plummeting
stock value is not. Assuming that they hire a competent investigator
who recognizes the implications, that thieving mutt may have
done your Client a real favor!
Since tax treatment as a casualty loss is typically
more than twice as favorable as a capital loss, IRC §165
could be compared to a "double indemnity" life insurance
clause that provides for a double payment in the event of
accidental death, where the deceased was the "casualty"
of some sudden, unforeseen, event.
REVIEW: The main
points thus far are:
- A "loss" according
to the tax code is pretty much as we define it in common
usage; and
- A "casualty loss"
according to the tax code is a loss due to certain specific
events; and
- A casualty loss can be worth much
more to the tax payer than an ordinary loss.
Obvious differences notwithstanding, I believe
that the investigator is well served by continuing to think
in terms of the familiar insurance company double indemnity
clause; as we proceed, it may be helpful to visualize, and/or
rationalize:
- Mom and the kids throwing Dad in front of a train after
his heart attack kills him
- Why insurance companies require investigation and proof
to support casualty claims
- Why legal representatives loathe to open that can of
worms might prefer to file for the standard death benefit
instead
Internal
Revenue Code §165
Now, let's look at the tax code. Bearing in mind that the
term "loss" refers exclusively to "casualty"
losses in this particular section of the Internal Revenue
Code, the relevant statutory provisions are as follows:
IRC
§165(a) says, "There shall be allowed
as a deduction any loss sustained during the taxable year
and not compensated for by insurance or otherwise."
These
casualty losses are categorized in IRC §165(c) as follows:
IRC
§165(c)(1) provides for, "Losses incurred
in a trade or business;"
IRC
§165(c)(2) provides for, "Losses incurred
in any transaction entered into for profit, though not connected
with a trade or business; and"
IRC§165(c)(3) provides for, "except
as provided in subsection (h), losses of property not connected
with a trade or business or a transaction entered into for
profit, if such losses arise from fire, storm, shipwreck,
or other casualty, or from theft.
Note that §165(c)(3) losses are handled,
"as provided in subsection (h)" It isn't
all that significant for our purposes, but subsection (h)
provides that (c)(3) losses are subject to a deductible formula
that does not apply to losses under (c)(1) and (c)(2) - that
deduction ($100 plus 10% of adjusted gross income) applies
only to losses not connected with business, or for-profit
transactions.
Let me address a common misconception. (common
beyond belief!)
No matter what anyone tells you, the words,
" if such losses arise from fire, storm, shipwreck, or
other casualty, or from theft" apply
to the losses identified in (c)(1), (c)(2), and (c)(3). In
other words, §165 casualty losses are categorized as;
business losses, personal investment losses, and other property
losses to the extent that [ANY OF] these losses are due to
the specified, "casualty" related events.
You cannot imagine how many Accountants, Lawyers,
and even Administrative Law Judges, read this section as if
(c)(1), (c)(2) and (c)(3) were separate sentences delimited
by periods, instead of semicolons, and conclude that theft
losses fall exclusively within the purview of §165(c)(3).
Rather than ask you to take my word for it,
I want to make this point perfectly clear because you will
find yourself arguing this point with people who should know
better over, and over again.
First, note that IF this were not the case,
IF §165 (c)(1) and §165(c)(2) applied to ordinary,
non-casualty losses, they would encompass the very same losses
properly filed under IRC §1211 as "capital losses"
rather than "deductions."
Logic, common sense, and statutory sentence
construction issues aside, the issue is dispositively resolved
by the form used to file these claims.
I direct your attention to IRS Form 4684, entitled,
"Casualties and Thefts." In looking at Form
4684, you will note that Section A,
on the front page of this form is entitled, "Personal
Use Property (Use this section to report casualties and thefts
of property not used in a trade or business or for income-producing
purposes.)" In other words, Section A is
properly used for declaring casualty losses cognizable under
IRC §165(c)(3).
Note that if that were not the case, the instructions
would say, "(Use this section to report casualties
and thefts of property [PERIOD]) Instead, the
instructions make it clear that you are supposed to use the
other section to report casualties and thefts of property
used in a trade or business, or for income-producing purposes.
It says so in the other section too, but first
notice that Section A, Line 11, provides for a $100 offset
against the loss, and Section A, Line 17 provides for another
offset of 10% of the taxpayer's adjusted gross income as per
§165(h) which only applies to §165(c)(3) losses.
In other words, if you claim a loss under (c)(3),
that loss is properly reduced by $100 and ten percent of the
taxpayer's adjusted gross income.
Now look at Section B of this form entitled,
"Business and Income-Producing Property
Casualty or Theft Loss." As you can see,
this is the section of the form that applies to casualty and
theft losses, when those losses are related to business cognizable
under (c)(1), or when those casualty and theft losses are
related to non-business, for-profit, transactions cognizable
under (c)(2).
Consistent with this explanation, you will note
that this section contains no provision for the above referenced
offsets as specified in subsection (h) that apply to losses
properly categorized as §165(c)(3), but do not apply
to losses cognizable under §165(c)(1) or §165(c)(2).
Fair warning -
if you completely understand this, you are going to find yourself
explaining it to lawyers, accountants, IRS representatives,
and Administrative Law Judges in Tax Court who oftentimes
have no clue. If you read many of the tax court decisions
marked, "Unsuitable for Publication," you
will see what I mean.
For those of you who do not investigate financial
scams, please note that your time has not been wasted. While
I am most interested in the application of §165(c)(2),
you will find that §165(c)(3) has a wide range of applications.
KEEP IN MIND that §165(c)(3) tax treatment is not nearly
as favorable as the tax deduction provided for losses properly
categorized as deductible pursuant to §165(c)(1) or §165(c)(2)
due to that previously referenced offsets per subsection (h).
For example, suppose you are approached to assist
in recovering valuables stolen during the course of a "home
invasion" strong arm robbery, or hired to track down
an expensive antique automobile that disappeared while undergoing
repairs. In these cases, it is important that you conduct
your investigation mindful of the potential IRC§165(c)(3)
tax implications.
Alternatively, consider a kidnapping case where
the Client pays out a million dollar ransom. It would behoove
your Client to know that, although extortion is not "theft,"
the loss would be properly deductible as a §165(c)(3)
casualty loss.
Rev.
Rul. 112-72, published January 1972,
addressed this specific issue and, while a ransom case may
be far afield of investment related theft loss issues, this
ruling serves to illustrate how broad the applicable definition
of theft can be.
This ruling specifically states that:
Considering the broad general meaning
of theft, it must be presumed that Congress used the term
"theft" so as to cover any theft, or felonious
taking of money or property by which a taxpayer sustains
a loss, whether defined and punishable under the penal codes
of the states as larceny, robbery, burglary, embezzlement,
extortion, kidnapping for ransom, threats, or blackmail.
The seminal case on this issue is Edwards
v. Bromberg, which was decided
in 1956 (and therefore quotes a different code section); quoted
in many §165 "theft" related cases, it stands
for the proposition that:
[The] word "theft" is not
like "larceny," a technical word of art with a
narrowly defined meaning but is, on the contrary, a word
of general and broad connotation, intended to cover and
covering any criminal appropriation of another's property
to the use of the taker, particularly including theft by
swindling, false pretenses, and any other form of guile.
To qualify as a "theft" within the meaning of IRC
§165, the taxpayer needs only to prove that his loss
resulted from an act that is illegal under the law of the
state where it occurred, and that the taking was done with
criminal intent.
REVIEW: The main
points thus far are:
- A "loss" according
to the tax code is pretty much as we define it in common
usage; and
- A "casualty loss"
according to the tax code is a loss due to certain specific
events; and
- A casualty loss can be worth much
more to the tax payer than an ordinary loss; and
- Internal Revenue Code §165 provides that casualty
losses are deductible; and
- IRC §165 categorizes casualty losses as: (c)(1)
business losses; (c)(2) personal
investment losses, and (c)(3)other property
losses; and
- IRC §165 requires that that these losses must be
due to "casualty" to be deductible; and
- IRC §165 recognizes theft as a specifically enumerated
casualty, and case law provides that the word "theft"
encompasses virtually any unlawful taking; and
- IRC §165(c)(3) claims are subject to the subsection
(h) offset, so they are less advantageous to the taxpayer
than they would be if properly categorized as (c)(1) or
(c)(2).
Practical
Applications
In some cases, especially those where the recovery
outlook is most dismal, it is entirely possible that the victim
of an investment scam could retain a Private Investigator,
incur significant investigative fees and expenses, recover
absolutely nothing, and yet find it to be cost effective,
and money well spent. If recovery efforts prove to be fruitless,
and all reasonable avenues of recovery are exhausted, there
may still be some light at the end of the tunnel in the form
of this tax deduction.
This is not your ordinary tax deduction. To
perfect a viable §165 filing, the Tax Payer must prove
that his situation meets the applicable criteria, and be able
to answer questions that you, as an investigator, are best
equipped to respond to. Time spent dotting "I's,"
crossing "T's" and diligently researching the tax
code can pay big dividends.
Real
World Example #1:
Suppose Joe Client reads various press releases
propounded by Charlie Crook, President, and Chief Janitor
of XYZ Corporation, which persuade him to believe various
and sundry fraudulent misrepresentations. "XYZ
Corporation, with millions in assets, and virtually no liabilities,
has discovered the cure for AIDS," or so
the story goes.
Acting upon this information, which was knowingly
and deliberately disseminated with the criminal intent to
defraud, Joe Client contacts his broker and invests $1M in
XYZ Corporation, fully intending to derive a profit.
Within the month, the scam is revealed, Charlie
Crook is arrested and convicted for violating numerous provisions
of the Securities Act of 1934, XYZ Corporation is forced into
bankruptcy, and Joe Client stands to recover $20K of his $1M
investment, rather than the $3M he was led to expect.
How would you break this down?
We have an individual, a transaction entered
into for profit, and a loss due to fraud that might qualify
as a deduction cognizable under §165(c)(2). What do you,
as the Client's Investigator, need to do to support this claim?
Do you feel like it has the potential to be viable?
As with any case, you need to completely document
the facts and circumstances, and explore all avenues of potential
recovery. Assuming that Charlie Crook and XYZ Corporation
are dead ends, do you see any other recovery potential?
How about your Client's Broker? Was your Client
a sophisticated investor? Was this an appropriate trade strategy
in light of his personal circumstances? What you have here
is an arbitration claim - and perhaps an extraordinarily good
one.
What you do not have is any viable §165(c)
claim - unless you manage to make the case against the Broker.
To qualify as a "theft" within the
meaning of IRC §165, the taxpayer must prove that his
loss resulted from an act that is illegal under the law of
the state where it occurred, and that the taking was done
with criminal intent.
Ask yourself, "Who took the Client's money?"
To support a §165 deduction, you must prove that the
person who took your Client's money did so with criminal intent.
The issue is called "privity,"
which relates to the connection, or relationship between parties.
A million dollar tax deduction is a big deal.
Unless your Client makes his arbitration case against Barry
Broker, the fact that your Client had no direct dealings with
Charlie Crook could conceivably cost him something in excess
of $300K.
See: Crowell
v. Commissioner
Real
World Example #2:
Suppose Joe Client met with Robert Cash who
had designed a machine that would convert $1 bills to $100
bills via a three stage process - the $1 are bleached, the
inks are separated into their constituent parts allowing them
to be reclaimed/reused and then the $1 bills are reprinted
using laser technology and the reclaimed ink. Robert Cash
has a functional prototype that Joe Client carefully examined,
and used.
In inviting Joe Client to their meeting, Robert
Cash suggested that he first stop by the bank and obtain some
crisp, new $1 bills. At the meeting, Joe Client was permitted
to feed these crisp, new $1 bills into Robert Cash's machine
which produced, damp, but otherwise apparently perfect $100
bills with an average turn around time of five minutes per
bill. Joe Client was allowed to keep the money, and encouraged
to have it examined by his bank. The head teller examined
the bills and reported that they were, by all appearances,
genuine.
After consulting with representatives of three
other banks (each of whom concurred that the bills appeared
to be genuine), Joe Client invested $250,000 in Robert Cash's
money making machine. Apparently, it did not occur to Joe
Client that a man who could make his own money would not need
an investor. Robert Cash promptly evaporated along with Joe
Client's investment.
How would you break this down?
We have an individual, a transaction entered
into for profit, and a loss due to fraud that might qualify
as a deduction cognizable under §165(c)(2). What do you,
as the Client's Investigator, need to do to support this claim?
Do you feel like it has the potential to be viable?
This fundamentally identical fact situation
was considered by the Court in the 1959 case, Richey
v. Commissioner where they held that theft-loss
deduction would be disallowed to avoid a frustration of sharply
defined public policy. While holding that the taxpayer had
brought himself within the literal requirements of §165(c),
the Court concluded that to allow the loss deduction would
constitute a severe and immediate frustration of the clearly
defined policy against counterfeiting obligations of the United
States.
Real
World Example #3:
Suppose Joe Client, a successful neurosurgeon,
attended a seminar in the Cayman Islands where Larry Lawyer
and Albert Accountant promoted Agris, a program they developed
calculated to minimize tax liabilities by funneling income
and assets thru a series of corporate entities and a complex
constellation of trusts.
As a direct consequence of the representations
made during that seminar, and a series of personal, one-on-one
encounters that followed, Joe Client was persuaded to retain
Larry and Albert to manage his finances. After paying a $25,000
set up cost to buy into the program, many of his assets were
liquidated and the funds were transferred to offshore accounts.
Most of his remaining assets were titled in the name of various
trusts that Larry and Albert controlled.
During the years that followed, Joe Client's
income was paid directly to a business management corporation
that paid him a nominal salary which he declared as income.
The remaining funds were passed around thru offshore entities
and charitable trusts, and Joe Client was provided monthly
statements demonstrating the program's effectiveness and justifying
the management fees that he paid Larry and Albert, which usually
averaged approximately $1000 per month.
Instead of paying annual income tax in excess
of $150K, Joe Client paid a few hundred, plus approximately
$12K a year in management fees; on balance, it was a wonderful
deal.
After five years, one of the Agris program's
clients was audited. Once the giggling stopped, the IRS initiated
a legal action to enjoin Larry Lawyer and Albert Accountant
from engaging in any more of this nonsense, and force them
to turn over their client list.
Within months, Joe Client was audited and advised
that moving all this money around was a useless exercise -
from the standpoint of the IRS, it was nothing more than razzle
dazzle voodoo utterly devoid of economic substance. Federal
authorities investigating the matter determined that Larry
Lawyer and Albert Accountant had masterminded this abusive
trust tax scheme, and neglected to file tax returns for many
years. They were subsequently indicted, buried in federal
tax liens, and they remain federal fugitives.
Their fraud scheme cost Joe Client the $25,000
set up fee and approximately $60,000 which they collected
as management fees.
Of course, that is no shade of what this really
"Cost" Joe Client - I am just talking about what
his involvement in the program put together by these characters
cost him out-of-pocket. In reality, that $85K is a mere "drop
in the bucket" compared to what the IRS is going to do
to him. Assuming that Joe Client is afflicted with the remarkable
hubris that it would take to try and characterize the money
he paid to these knuckleheads as some kind of investment loss,
how would you break this down?
We have an individual, who relied on the representations
of an accountant, and an attorney in engaging in a series
of transactions that would appear to be cognizable under §165(c)(2)
as they were entered into in an effort to make a profit .
. . or maybe not.
Perhaps the government would hold that Joe Client
did not enter into these transactions intending to generate
profit, but rather in an effort to minimize tax liability.
Would that mean that Joe Client incurred losses related to
trade or business cognizable under §165(c)(1)?
Perhaps this series of transactions could be
correctly classified as a loss that was neither business related,
nor entered into for profit, thereby cognizable under §165(c)(3)?
In any event, what do you, as the Client's Investigator,
need to do to support this claim? Do you feel like it has
the potential to be viable?
The IRS representatives you deal with are going
to make references to snowballs and furnaces, and conjure
up images of a guy with a pointed tail and pitchfork wearing
ice skates. That pretty much sums things up.
Succinctly put, taxpayers are estopped from
claiming a deduction for losses that would otherwise be cognizable
under IRC §165 if their investment was intended to reduce
or postpone taxes rather than to earn profits.
Once upon a time, a Court saw things differently;
in Perry A. Nichols v. Commissioner,
43 T.C. 842 (1965), the Court ruled that it didn't matter
and permitted Nichols to take the disputed deduction. Anyone
thinking they can "hang their hat" on that case
would do well to revue Rev.
Rul. 70-33.
Similarly, in the case Omerza
v. Commissioner, the United States
Court of Appeals for the Third Circuit stated that:
" . . . if a transaction is devoid
of economic substance . . . it simply is not recognized
for federal taxation purposes, for better or for worse.
This denial of recognition means that a sham transaction
. . . cannot be the basis for a deductible "loss."
In essence, the court holds that
taxpayers are estopped from claiming a deduction for losses
procured by fraud, where the objective evidence demonstrates
that the purpose of their investment was to reduce or postpone
taxes rather than to earn profits. Having stipulated that
the underlying transaction was a sham, the purported expectation
of a profit is irrelevant and their claimed deductible loss
must be denied."
Sometimes, Judges can be remarkably eloquent
in their expression of position; I particularly enjoyed the
way in which the Court characterized this case.
"In this case, the parties have
asked us to preside over the ceremony in which we nail down
the coffin to which we consign the lost hopes of Mr. Graham's
gullible investors to salvage some residual tax benefit
from their participation in the spurious tax shelters that
he promoted. We have invariably held that these tax shelters
lacked economic substance and that the participants were
not entitled to deduct their out-of-pocket expenditures
under section 165(c)(2)."
The proper test for whether a transaction is
a sham is whether the transaction has any practicable economic
effects other than the creation of income tax losses.
REVIEW: The main
points thus far are:
- A "loss" according
to the tax code is pretty much as we define it in common
usage; and
- A "casualty loss"
according to the tax code is a loss due to certain specific
events; and
- A casualty loss can be worth much
more to the tax payer than an ordinary loss; and
- Internal Revenue Code §165 provides that casualty
losses are deductible; and
- IRC §165 categorizes casualty losses as: (c)(1)
business losses; (c)(2) personal
investment losses, and (c)(3)other property
losses; and
- IRC §165 requires that that these losses must be
due to "casualty" to be deductible; and
- IRC §165 recognizes theft as a specifically enumerated
casualty, and case law provides that the word "theft"
encompasses virtually any unlawful taking.
- IRC §165 claims are subject to some serious pitfalls
established via case law, particularly, privity, public
policy, and tax sham transactions
Closing
Comments:
I chose to cite examples in which there were unforeseen perils
in order to best profile the most common areas of concern.
I do not wish to leave you with the impression that availing
oneself of relief that Congress unquestionably intended is
fraught with insurmountable obstacles - it isn't.
In Schneider
v. Commissioner, the Court held
that Schneider was entitled to an IRC §165 deduction
under circumstances where Schneider entrusted investment capital
to a con artist who outright stole it, notwithstanding the
fact that Schneider made no real effort to recover his loss.
I particularly like this case as it was the Petitioner's "extensive
investigation" that saved the day. The Court found the
fact that the IRS was unable to collect from the perpetrator
to be persuasive evidence that any effort Schneider might
have made would have been a waste of time and effort.
Ahem, kick the podium, slap the pointer on the desk . . .
"The Court found the fact that the IRS was
unable to collect from the perpetrator to be persuasive evidence
that any effort Schneider might have made would have been
a waste of time and effort." If you are
involved in a §165 case, you will check for unsettled
IRS tax liens won't you!
In Ander
v. Commissioner, the Court held
that Ander was entitled to include attorney's fees as part
of her theft loss deduction, after her husband stole, forged
and cashed checks related to the sale of their jointly owned
residence, using the money for his own use. The Court declined
to accept the IRS' position, contending instead that the attorney's
fees were analogous to the costs of recovery or salvage which
were so closely identified and connected with the theft loss
itself as to be further or additional or collateral theft
losses. Noting that the attorney's fee was paid solely in
connection with the taxpayer's action against her husband
and that this action was based entirely on the husband's conversion
by forgery, the court made an analogy between a necessary
recovery cost of stolen property and a necessary repair cost
to damaged property. The court said that it would be anomalous
in the extreme if expenses paid to reduce the amount of a
loss were not themselves deductible in full.
In the wonderfully bizarre case of Bennett
v. Commissioner, the Court held
that the taxpayer was entitled to a §165 deduction related
to an armed robbery. The taxpayer, a professional bookmaker,
satisfied the Court that a police report was filed along with
a report to the Federal Bureau of Investigation. The case
was investigated, suspects were identified and apprehended,
but no money was ever recovered.
Clients who have been defrauded in an investment scam often
stand to receive little to no "bottom line" benefit
under IRC §1211, but a properly supported IRC §165
filing can result in a recovery dramatically exceeding what
they would have received consequent to a successful lawsuit
- even assuming that the crook paid the judgment.
To perfect a viable IRC 165(c)(2) filing, the Client must
PROVE, inter alia, that the investment loss was due
to theft, the transaction has been completed, and there is
no reasonable likelihood of recovery -- that's our job. A
Client who might derive no benefit from a capital loss, could
stand to recover 35% (net) of their theft loss based entirely
on your work.
Help your Clients deal with tax professionals reluctant to
fight the battle that inevitably accompanies a §165 deduction.
IRC §1211 is the easy way out for them, and you should
not stand by quietly while your Client's best interests are
sacrificed by a tax professional afraid to fight for the benefits
that Congress intended that they have.
Once you have successfully made that case, do not let anyone
undermine your hard work by categorizing your §165(c)(2)
theft loss under §165(c)(3), thereby subjecting it to
offsets that should not apply.
Don't look at the IRS as your enemy, think of them as protecting
insurance company stockholders from those who would push a
dead guy in front of a train in an effort to collect under
a "double indemnity" clause. Dot your I's, cross
your T's and study relevant case law.
The IRS does not make it easy, but this can be done, and
the tax deduction can be worth a lot more than many of these
victims actually net consequent to their law suits, and other
recovery efforts.
UPDATE 2009: The IRS Addresses These Issues
Directly
In the wake of the Madoff case, the IRS has published rulings
specifically addressing IRC 165(c)(2), and its appropriate
application to investment fraud, as well as providing "safe
harbor" procedures for those who were affected.
These documents should make it easier for you to explain
these policies and procedures to clients.
CAVEAT
If you are involved in the investigation of
investment fraud, and you develop the information and evidence
necessary to support an appropriate deduction cognizable under
IRC 165(c)(2), you will probably, and properly, be required
to submit an Affidavit in support of that deduction. It may
be in the best interests of your Client to include language
in your Affidavit distinguishing yourself from the cottage
industry of those providing IRC 165 related services on a
contingent fee basis. I have attached an example taken from
a Declaration that I recently prepared.
COMMENT
If
your involvement in the investigation of investment fraud
cases is widely publicized, you are likely to be contacted
by individuals who have horror stories to share regarding
companies and individuals that solicited them to handle IRC
165(c)(2) tax deduction issues on their behalf, for a percentage
of the deduction, on a "no recovery, no fee" basis.
I
am not going to wade into that imbroglio, other than to say
that the IRS Criminal Investigation Division is investigating
some of these "165 service providers," and I believe
that indictments are long overdue regarding the fraud that
is pervasive within that industry.
I
am not suggesting that there are no legitimate providers of
services related to these deductions, nor am I alleging that
a contingent fee contract implicates fraud, but when
there is fraud, the fraud works like this.
Joe
Investor loses a million dollars. Charles the Conniver solicits
Joe and touts the potential to recover hundreds of thousands
of dollars for Joe by claiming a tax deductible investment
fraud casualty loss pursuant to the provisions of IRC Section
165. In soliciting this business Charlie proffers the "no
recovery, no fee" aspect of his contract as an inducement.
"After all," he argues, "what
do you have to lose?"
Unfortunately,
Joe Investor generally has no idea what he stands to lose.
What Charles the Conniver fails to explain is
the fact that the entire tax system relies upon "voluntary
compliance." Consequently, this deduction (as is true
for a host of completely ridiculous claims for other deductions
I could name) can be expected to be initially
processed without issue whether it is legitimate
or not. Joe Investor will almost always initially
enjoy the benefit of a windfall deduction, and Charles the
Conniver will collect his fee.
That the deduction will initially
be processed without issue is to be expected . . . just as
it is to be expected that this IRC 165 deduction will subsequently
be audited when the IRS gets around to it, generally a couple
of years down the road.
That the IRS will eventually audit this deduction
is to be expected . . . just as it is to be expected that
they will initially deny it, requiring
that Joe Investor prove he is entitled to it, or pay the assessment
to include the amount of the deduction, interest and penalties.
Charlie Conniver knew very well that was coming, but by that
time, this fraudster is long gone along with his fee.
That is how they system works, the cottage industry
of Charlie Connivers out there perpetrating fraud are exploiting
it, and the IRS is aware of it.
Having said that, my purpose was just to make
you aware of the potentialities for fraud. I would also say
that this should be of no concern to you. If you investigate
a case where your client suffers a legitimate casualty loss
cognizable under any of the provisions of Internal Revenue
Code Section 165, no IRS agent is going to come bang on your
door for attempting to deal with that accordingly; it is the
charlatans out there proposing to pound square pegs into round
holes for a fee that they are concerned with - as they should
be.
If you encounter a victim of this sort of fraud,
please let me know. I am putting together a collection of
case studies.
UPDATE: April 2011
Last year, in April 2010, the government filed a Complaint for a Permanent Injunction in an effort to enjoin Tobias H. Elsass, Sensible Tax Services, Inc., and the Fraud Recovery Group, Inc., from "directly or indirectly promoting the “theft loss” scheme described herein, and from engaging in any other conduct subject to penalty under I.R.C. Sections 6694, 6695, 6700, and 6701, and from engaging in any other conduct that substantially interferes with the proper administration and enforcement of the internal revenue laws."
I
welcome your comments,
questions and suggestions. |